SEC Amends Form ADV and Investment Adviser Recordkeeping Rules

The U.S. Securities and Exchange Commission (SEC) recently adopted amendments to Form ADV and to Rule 204-2 (Recordkeeping Rule), as well as technical amendments to other rules under the Investment Advisers Act of 1940 (Advisers Act) (collectively, Final Rule).1 The amendments were proposed on May 20, 2015 with a comment period ending August 11, 2015.2 The Final Rule will become effective on October 31, 2016, with a compliance date of October 1, 2017 for the amendments to Form ADV and the Advisers Act rules.

As a result of the Final Rule, advisers registering on Form ADV will be required to report additional information – with a focus on separately managed accounts (SMAs) – which will be made available to the general public. In addition, multiple private fund advisers operating as a single advisory business will be able to register using a single Form ADV. Finally, advisers will be required to comply with certain recordkeeping requirements related to written communications of performance or securities recommendations to any person. The Final Rule is designed to: fill what the SEC believes are certain data gaps regarding SMAs; assist the SEC in carrying out its risk-based examination program; and further other monitoring activities.

Impact of the Final Rule on Advisers

The Final Rule will impose reporting and record keeping requirements on advisers, including:

Advisers to SMAs will be required to provide additional information on an aggregate basis,3including: regulatory assets under management (RAUM) in 12 categories of assets; the use of derivatives and borrowings; and the role of custodians.

Advisers will be required to disclose additional information about the adviser’s Chief Compliance Officer (CCO).

Umbrella registration will be available for eligible private fund advisers operating as a single advisory business.

Despite comments in favor of expanding the scope of umbrella registration to apply to other types of advisers, the SEC adopted the umbrella registration amendments as proposed. Specifically, commenters favored expanding umbrella registration to non-U.S. filing advisers as well as to advisers that operate a single advisory business beyond those described in Condition 1 of the Final Rule Release (for example, to include registered investment companies and business development companies).

Clarifying amendments to Form ADV include: registration requirements for newly created entities (specifically including advisers that changed their structure or legal status in connection with succession planning); and disclosure requirements related to funds of funds.

Certain recordkeeping rules have been amended, requiring advisers to now maintain records related to communications distributed directly or indirectly to any person, where such communications demonstrate the calculation of performance or of a rate of return, or include securities recommendations.4

Notable Changes from the Proposal to the Final Rule

The Final Rule reflects the following significant changes from the Proposal:

Information as to Separately Managed Accounts

Where in certain instances the Proposal required more specific reporting on SMAs, the Final Rule permits reporting on an aggregate level (for example, on gross notional exposure). Instructions were clarified to confirm that advisers, when reporting on investments by asset category, do not need to look through an SMA’s investments in funds or ETFs and report the underlying asset type in Section 5.K.(1) of Schedule D.

Reporting on SMA borrowings and derivatives in Section 5.K.(2) of Schedule D will be based on RAUM, instead of net assets.

Instructions were clarified to indicate that a sub-adviser to an SMA should provide information only about the portion of the account that it sub-advises.

Additional Information regarding Investment Advisers

Advisers will not be required to disclose the identity of anyother person compensating/employing the CCO if such other person is a registered investment company advised by the adviser.

The Final Rule uses the existing term “non-United States person” (instead of the term “non-U.S. client” as proposed) when discussing an adviser’s reporting of RAUM attributable to non-U.S. clients.5

Advisers must report the RAUM of all parallel managed accounts related to a registered investment company (or series thereof) or business development company advised by the adviser. Previously, advisers were not required to provide this information.

The Final Rule limits reporting regarding ownership in Section 7.B.(1) of Schedule D to 3(c)(1) funds6 and now requires an adviser to disclose whether it limits sales of a fund to qualified clients, instead of reporting percentage ownership of the fund by qualified clients as proposed in new Question 15(b).7

Amendments to Form ADV

Disclosures Regarding Separately Managed Accounts

The Final Rule requires advisers to annually report in Item 5 of Form ADV and Section 5 of Schedule D the percentage of SMA RAUM invested in each of 12 broad asset categories.8 Advisers may use their own consistently applied internal methodologies and the conventions of their service providers to determine how to categorize assets.9 However, advisers should not look through funds or ETFs to report the underlying asset type.

Regarding derivatives and borrowings, the Final Rule requires advisers with at least $500 million, but less than $10 billion, in RAUM attributable to SMAs to provide certain information as part of filing their annual updating amendment to Form ADV. Specifically, advisers must provide the following information in Section 5.K. of Schedule D:

Advisers with more than $500 million. The Final Rule requires advisers (with RAUM of at least $10 million10) to report the amount of RAUM in SMAs, and dollar amount of borrowings attributable to those assets, based on three categories of gross notional exposure: less than 10%, 10-149%, and 150% or more.

Advisers with at least $10 billion. In addition to the reporting described above, the Final Rule requires these advisers to report (based on RAUM in SMAs) the derivatives exposure in each of six categories of derivatives.11 Information regarding borrowings must be reported based on the total dollar amount of borrowings that corresponds to the different ranges of gross notional exposure. An adviser also may include a narrative description of how the adviser uses derivatives and borrowings in its management of SMAs.

The Final Rule also requires that advisers identify any custodians that account for at least 10% of SMA RAUM and the amount held at each custodian.

Additional Identifying Disclosures

CIK Information

Currently, advisers that are public reporting companies12 must report their Central Index Key number (CIK Number). The Final Rule instead requires advisers to report any CIK Numbers assigned to them, regardless of public reporting company status. An entity may have multiple CIK Numbers if it is registered with the SEC in other capacities (for example, as a transfer agent).

Social Media Sites

Currently, advisers must report their website address. In addition, the Final Rule now requires disclosure of any social media accounts used by the adviser where the adviser controls the content, including the addresses of the adviser’s social media pages. While there is no definition of “social media platforms,” the Amended Form ADV and Schedule D include Twitter, Facebook and LinkedIn.

Office Location and Activity Disclosure

Currently, advisers must report information as to where they do business, including identifying their principal office and place of business as well as the five largest offices (by number of employees) where they conduct advisory activities. Advisers must amend this information promptly if it becomes inaccurate. The Final Rule now requires that advisers report the total number of offices where they offer investment advisory services and the 25 largest offices (by number of employees). Advisers are required to report the following for each such office:

Business activities that take place, based upon a list of activities provided by the SEC; and

Any other investment activities conducted.

In response to comments, the Final Rule states that Section 1.F. of Schedule D should be updated as part of an adviser’s annual updating amendment.

Chief Compliance Officer Outsourcing

Currently, advisers are required to provide the name and contact information of the adviser’s CCO. The Final Rule now also requires an adviser to report whether or not its CCO is compensated or employed by any person other than the adviser (or a related person of the adviser) for providing chief compliance officer services to the adviser. If applicable, the adviser would be required to disclose the name and IRS Employer Identification Number (if any) of that service provider. However, advisers are not required to disclose the identity of a related person of the adviser or the identity of another person compensating or employing the CCO, if such other person is an investment company registered under the Investment Company Act of 1940 and is advised by the adviser.13

Adviser Asset Approximation

Currently, advisers with assets of $1 billion or more are required to check a specific box to indicate such status.14 As a result of the Final Rule, those advisers are now required to report their own assets (i.e., balance sheet assets, not assets under management) within the following ranges: $1 billion to less than $10 billion, $10 billion to less than $50 billion, and $50 billion or more.

Additional Information about Advisory Business

The Final Rule amends Item 5 of Part 1A of Form ADV to require more specific information about the amount and proportion of an adviser’s RAUM by client type. Currently, advisers are required to disclose the following in percentile ranges: number of advisory clients; types of advisory clients; and RAUM by client type. As a result of the Final Rule, advisers are required to report the number (rather than percentage) of clients and the amount (rather than percentage) of RAUM attributable to each category of client. Notably, advisers with fewer than five clients in a particular category need not disclose the actual number of clients, and can instead check a box indicating that they service fewer than five of a particular client type.15

Currently, an adviser must disclose the number (in the form of a range) of clients to whom the adviser provided advisory services during the most recent fiscal year. Instead, the Final Rule requires advisers to disclose the number of clients the adviser provided advisory services to, but for whom the adviser did not manage regulatory assets, such as non-discretionary accounts or one-time financial plans. Also, Form ADV now will require an adviser to indicate if it reported client assets in Part 2A of Form ADV in a different manner than the RAUM it reported in Part 1A.16

Currently, an adviser is required to report the percentage of its clients that are non-U.S. persons. Under this reporting regime, an adviser could report a high percentage of clients that are non-U.S. persons even though the RAUM attributable to those clients makes up only a small percentage of the adviser’s overall RAUM. To better understand the adviser’s relationship with non-U.S. clients, the Final Rule requires reporting the approximate amount of an adviser’s total RAUM attributable to clients that are non-U.S. persons. As a result, a foreign adviser registering with the SEC, but with a principal place of business outside of the United States, would be required to report information pertaining to the non-U.S. portion of its business.

The Final Rule amends Section 5.G.(3) of Schedule D and requires an adviser to report RAUM of all “parallel managed accounts”17 related to a registered investment company (or series thereof) or business development company advised by the adviser. The SEC noted that this information would assist the SEC staff in addressing how an adviser manages conflicts of interest, and also show the extent of any shift in assets between parallel managed accounts and registered investment companies or business development companies.18 This requirement tracks a similar provision in Form PF for parallel managed accounts of private funds.

Currently, Section 5.I. of Part 1A obligates an adviser to disclose whether it services a wrap fee program as either a sponsor or a portfolio manager. The Final Rule will additionally require disclosure of: the name and sponsor of each wrap fee program the adviser manages; the SEC File Number and CRD Number for each sponsor of a wrap fee program; and the aggregate value of RAUM attributable to the adviser’s role as a sponsor and/or portfolio manager of the wrap fee program.

Financial Industry Affiliation and Private Fund Reporting Disclosures

The Final Rule requires an adviser to a 3(c)(1) fund19 to report whether or not it limits sales of a fund to qualified clients. In addition, disclosure of identifying numbers, registration numbers and CIK Numbers of financial service providers is required in Sections 7.A. and 7.B.(1).

Umbrella Registration

Background

When the private adviser exemption was repealed by the Dodd-Frank Act,20 advisers to private funds were required to register under the Advisers Act. Tax, legal and regulatory considerations led many private fund advisers to organize and operate a group of special purpose entities (SPEs) that are separate legal entities, in order to manage the advisers’ sponsored private funds. Even though these groups of related advisers generally operate as a single advisory business, because each SPE could be deemed to be acting as an investment adviser, the sponsor often registers them as separate investment advisers. In 2012, the SEC staff provided relief in the form of a no-action letter to the American Bar Association allowing a private fund adviser to file a single Form ADV (umbrella registration) on behalf of itself and other advisers that were controlled by or under common control with that filing adviser.21 However, Form ADV was designed to accommodate registration by a single legal entity. As a result, the registration of multiple legal entities operating a single advisory business on a single Form ADV led to confusing and inconsistent disclosures. Through a series of Form ADV amendments, the SEC has addressed these issues.

Notably, the Final Rule does not identify the universe of advisers that can rely on umbrella registration and instead lists several conditions that must be satisfied in order for a group of related advisers to take advantage of the umbrella registration provisions.

Qualifying for Umbrella Registration

An adviser (filing adviser) is required to file Parts 1 and 2 of a single Form ADV that includes all required information about itself and each other adviser (relying advisers), to use an umbrella registration to satisfy the requirements of Form ADV.22 While commenters suggested expanding umbrella registration to apply to other types of advisers besides private fund advisers, the SEC did not do so.23

The Final Rule adopts the same conditions as in the ABA Letter, permitting umbrella registration if a group of related advisers is operating a single advisory business where each of the relying advisers is controlled by or under common control with the filing adviser (together, all advisers), and in accordance with the following:

All advisers advise only private funds and SMAs for qualified clients who are eligible to invest in those private funds, and whose accounts pursue substantially similar investment objectives and strategies as those private funds;

The principal office and place of business of the filing adviser is in the United States;24

Each relying adviser, its employees and those acting on the relying adviser’s behalf are “persons associated with”25 the filing adviser, and thus under the supervision and control of the filing adviser;

The relying advisers’ advisory activities are governed by the Advisers Act and relying advisers are subject to examination by the SEC; and

All advisers operate under a single code of ethics, single set of written policies and procedures, and have the same CCO.

New Schedule R and Amendments to Schedule D of Form ADV

To clarify and provide additional disclosure, the Final Rule requires completion of new Schedule R for each relying adviser with respect to certain identifying information, including: organizational form; ownership; and control persons. The Final Rule amends Schedule D to require identification of the filing adviser and relying advisers that manage or sponsor private funds reported on Form ADV.

Clarifying and Technical Amendments to Form ADV

To provide clarity for advisers completing Form ADV and to encourage more reliable and consistent disclosure, the SEC adopted minor amendments throughout Form ADV (including clarifications to technical amendments to titles, questions, instructions, and the glossary). For example, the SEC amended:

Item 8.H. of Part 1A regarding client referrals, which is now two items, covering: (1) compensation paid to non-employees; and (2) compensation paid to employees above their regular salary.

Section 9.C. of Schedule D regarding independent public accountants that perform surprise examinations, who now must indicate: their PCAOB-assigned number; and whether any reports prepared by such firm since the last annual updating amendment contain unqualified opinions.

Amendments to Investment Advisers Act Rules

Amendments to the Recordkeeping Rule

The Final Rule includes two amendments to the Recordkeeping Rule. First, rule 204-2(a)(16) now will require advisers to document and preserve calculations that support performance claims made in materials distributed, directly or indirectly, to any person; currently this reporting only applies to claims distributed or circulated to 10 or more persons. Second, the SEC amended rule 204-2(a)(7) to add that advisers must maintain originals of all written communications received and copies of written communications sent, relating to the performance or rate of return of any or all managed accounts or securities recommendations. The Final Rule applies to all communications distributed after the compliance date and, as such, will apply to communications that include performance predating the compliance date.

Technical Amendments to Advisers Act Rules

The SEC removed rule provisions under the Advisers Act containing lapsed transition periods: from the Dodd-Frank Act; and from effective amendments to Form ADV regarding electronic filing of brochures required by Part 2A, including:

Rule 203-1(e) (expired transition period for companies relying on the “private adviser” exemption);

Rule 203-1(b) (expired transition period for electronic filing); and

Rule 204-1(c) and rule 204-3(g) (expired transition period to electronically file a Part 2A brochure).

Effective and Compliance Date

The Final Rule will become effective on October 31, 2016.

The compliance date for Form ADV amendments is October 1, 2017. Advisers filing an initial Form ADV or an amendment to an existing Form ADV on or after October 1, 2017 will be required to provide responses to the form revisions indicated in the Final Rule.

Similarly, the compliance date for amendments to the Advisers Act Rules is October 1, 2017. Communications circulated or distributed on or after this date will be subject to the recordkeeping requirements specified in the Final Rule.